As the costs of higher education continue to rise, people are turning to tax-advantaged 529 savings plans to help fund their children’s education expenses. A 529 savings plan is a state-sponsored investment plan that offers tax-deferred growth and tax-free withdrawals when used for qualified education expenses. In addition, some states offer their residents additional tax benefits such as tax deductions on in-state plans, tax breaks for contributions, or tax credits. 1
But what happens when there are excess funds in a 529 account that go unused? For example, a beneficiary may receive a scholarship or decide to go to a less expensive school than originally planned or may even decide to forgo college altogether. Starting in 2024, the SECURE 2.0 Act allows account holders to transfer up to a lifetime limit of $35,000 to a Roth IRA for a beneficiary. This new rule can help beneficiaries avoid taxes and the standard 10% penalty for nonqualified 529 withdrawals.
This is a great solution for excess 529 funds as it allows beneficiaries to start saving for retirement in addition to covering qualified education expenses. But does it make sense to purposely overfund a 529 with the intention to roll it over into a tax-free Roth IRA? There are a few requirements that are important to note before attempting this maneuver:
• The 529 account needs to be at least 15 years old prior to executing a rollover.
• The IRS limits the annual amount one can contribute to a Roth IRA. In 2024, the contribution limit is $7,000 (plus $1,000 if over the age of 50). Thus, the beneficiary would have to spread the rollover over multiple years to reach the $35,000 lifetime limit. 2
• The beneficiary of the 529 plan must be the same as the account owner of the Roth IRA.
• The 529 beneficiary/Roth IRA account owner must have earned income at least equal to the amount of the rollover. 3
These requirements are stated in the current tax law, but some of the nuances of actual implementation remain vague. For example, it is unclear if changing the 529 beneficiary triggers a new 15-year holding period. Although further guidance from the IRS may clarify or change the interpretation of the law, you still might consider taking advantage of this new rule if you find yourself with unused 529 funds.
Finally, if you have an overfunded 529 account and a balance beyond the $35,000 lifetime Roth rollover limit, there remains another path for the excess funds. 529 account owners still have the power to change the designated beneficiary to another eligible individual, such as a grandchild, allowing them to continue using the 529 account for qualified educational expenses.
Funding a Roth IRA with 529 funds should not be the primary goal of a 529 account; rather, it should be considered as a potential backup option if the account is left with unused excess funds. If you find yourself in this situation, your team at Sand Hill is available to assist with a 529-to-Roth rollover or discuss other options available for your specific circumstances.
1 - Please check home state plan for potential state tax savings and advantages.
2 - The annual contribution limit would be the beneficiary’s, not the account owner’s.
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